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When The Bond Market Speaks, Traders Listen

|Includes: SPY, ProShares UltraShort 20+ Year Treasury ETF (TBT), TLT

Since the stock market rally began in March 2009 much of the focus has been on the U.S. Dollar, gold, oil, copper, and the financial stocks. While these sectors have all been very important to the rally, there is one sector that has been overshadowed and may be the most important. It is the 10 year bond yield.

As the U.S. Treasury and the Federal Reserve Bank blatantly try and inflate the markets back to health, there is one problem that stands in their way; high yields. Since this stock market rally began there has not been a single ten percent correction. The only corrections that have occurred in the stock market were in June 2009 and January 2010. Note the performance of the SPDR S&P 500 ETF (NYSE: SPY). Both corrections lasted about one month. What many traders and investors failed to realize is that the 10 year bond yield moved up to about 4.00 percent when these corrections took place. In June 2009, the 10 year bond yield traded just above 4.00 percent and a stock market correction took place. In January 2010, the 10 year bond yield traded as high as 3.92 percent and we had a sharp one month correction in the stock market.

It seems the stock markets comfort zone occurs when the 10 year bond yield stays between 3.80% and 3.40%. When the rates remain at these levels the stock market seems to take its cue that it is safe to move higher. Today, the 10 year bond yield traded as high as 3.93% and the market has sold off from its high. When the 10 year bond yield gets above 4.00% it would be prudent to watch out as the rug could be pulled from this light volume stock market rally.

Traders that are looking to trade the yields to the long side or short bond prices can trade the ProShares UltraShort 20+ Year Treasury ETF (NYSE:TBT). This is an ultra fund which means that it is two times short the bond prices. If traders and investors would like to trade bonds prices to the long side they can use the iShares Lehman 20+ Year Treasury Bond ETF (NYSE:TLT).

Nicholas Santiago
Chief Market Strategist